America is indeed exceptional – with government debt

“In its newly released April 2018 Fiscal Monitor, the International Monetary Fund projected that the United States is the only — yes, only — advanced economy in the world expected to have its debt burden get worse over the next five years.” – Washington Post

Tax cuts, and the possibility of more or extended tax cuts. Who’s going to pay the government’s demographically-driven growing bills?

10 thoughts on “America is indeed exceptional – with government debt”

I work with a plan duration of younger spuose to 100. 52 years in our case. So somewhere between your duration and Michael’s.

We use a fixed withdrawal approach in our planning (indexed at 2% inflation) which is approximately 3% of assets, without counting home/vacation real estate, and that approach has come through Monte Carlo analysis well. I have run a few other cases as well in alternate analysis including a variable income strategy but I think 3% fixed will work for us.

I use this as the base case for wealth managers when they try and pitch for management of our portfolio and a variety of investment banks have somewhat relunctantly agreed that they have difficulty adding value to our self directed approach. The simulations in their internal software has also yielded similar sustainability results for this withdrawal approach.

We are not quite retired yet. A few years from now will be the start. At that point the fixed rate may be 2.7 or 2.8% based on our current aggressive savings rate.

I am curious in one aspect of your case. Were you retired in 2008 and if so, was the income drop onerous?

At a 2.5% floating withdrawal rate, I agree in your (or TD Wealth’s) assessment of the probability of success. In fact I would judge your success probability as higher than the librarian who exited the market.

Runaway inflation is never a zero probability in my opinion…

A diversified set of stocks, some low fee equity ETFs for worldwide diversification, and a sprinkling of other real assets (like real estate, infrastructure plays, etc.) forms the overwhelming majority of our portfolio. It is the best path we have found, so far…

But I am always looking for ideas and these discussions are excellent. Thank you both!

I hate to be a contrarian here, but increases in government debt is statistically better for investor returns. If you cross reference returns in the usa against times of debt expansions vs contractions you will see that investors should wish for more debt as returns increase in years of debt expansion. I know it sounds crazy and intuitively at first glance this cannot make sense, but think about the mechanics at the macro level. Expanding debt increases the money supply and ultimately stimulates the economy. As for paying for the debt, its just managed in perpetuity…in the US it was paid off only once in history, i think the 1800s, otherwise its always been there.

You make a good point. So for the medium term this indeed could be bullish. But with debt increasing, rates increasing and de-regulation in the financial sector, aren’t we setting up for another potential financial crisis?

That is a really good but not so easy question to answer. I have been struggling with these issues for a while. Essentially word on the street is that after the 08 crisis, regulation went too far and any move somewhat back would be good. But my view is that no one really knows for sure. The financial system is so complex that even a seemingly small change could have a large negative ripple effect. Rising rates done slowly poses little risk to the market, its quick unforseen shocks that have the biggest effect.

For fun, here is what i am watching…The fed now telegraphs everything it does to lower volatility and rates are going up slowly (neutral). Also they are unwinding their quantitative easing debt positions which is lowering the money supply (negative). With higher interest rates, and deregulation banks will want to make more loans to take advantage of the spread, increasing the money supply (positive). The recent tax cut will increase the money supply (positive). More stock buybacks vs ipo’s lowering the supply of global stocks (positive). Almost all economies in the world have positive gdp (positive). Flatish yield curve (negative). LEI is in positive territory (positive). Lots of moving parts, but mostly positive for what is widely known.

I like to work on probabilities so although a financial crisis is certainly bad, we should distinguish between a cyclical bear market brought on by a recession and a financial crisis which is a rare occurance. If you were a betting man (which you are if you own stock) you would have to realize that its logical to bet against a financial crisis and even a bear market because statistically, stocks over the long run, go up most of the time. You need to take your lumps during these natural down cycles knowing that most of the time you will be doing quite fine. Its never the end of the world as the media tries to make you believe.

Put another way, if the odds of winning at a casino were 66% in your favour, you would be crazy to not play just because on 34 % of your days you would lose money. That in fact is the approximate probability ratio of the stock market. The fear of the ups and downs of the business cycle is unfortunately what keeps small investors in cash, bonds and defensive portfolio positions that are not market weighted and why they under perform the market.

A td ameritrade report recently provided some interesting statistics: small discount investors have been returning under 3 % longrun returns, greatly underperforming the market. The point here, to me, is that the small investor has to stop trading so much and stop emotion trading. Managed high wealth accounts have substantially better returns. I hate to say it, but most small investors should just get a market ETF.

Back to your question, are we setting up for another financial crisis? Answer: No one really knows for sure. If everybody believed this as a certainty, the market would crash instantly trying to get their money out. Investing is a probabilities game, so i would say that its possible but not probable in the short run. In the longrun, i do believe we will have another crisis along with recessions, droughts, locusts, frogs etc…. But we will also have huge bull run expansions that will by far make up for these. We just have to accept that economic cycles are normal and that they should not be feared.

Ok, so Japan is an interesting anomaly that does not really follow world trends. Its market structure is very different than those of other G countries, even its population age breakdown is different, its culture and history may also play a role. I remember peter lynch once saying that the Japanese markets did not make sense to him as they relate to evaluation metrics. In the end, its difficult to determine what has caused japanese markets to do so poorly over such a long time, even with negative interest rates! In this case, i really have no clue why its played out like this. other than they are just weird.

That being said, the world is a big place, and if you want to stack the deck against this type of investment catastrophy, you need to stay diversified globally. Global returns as a whole do not suffer from secular bear markets. Is it possible? yes, probable? No. This brings us back to probabilities. Regardless of the terrible things that may or may not happen to markets going forwards, we all have to make the best bets we can. The only safe way to do this is to maximize returns over long periods by staying invested in a weigthed portfolio of diversified quality stocks in order to receive market like returns. This is the secret sauce, any deviation from this will lower your returns below the market average in the long run. Then you run the risk of having to eat cat food in your seventies. Lets put the risk into perspective, there are no long run scenarios (20 year rolling average) in the sp500 where you would have been better off in cash than stocks….ever….even factoring in the great depression. The same goes for bonds….well mostly, they did win a couple of twenty year averages if i recall, but by a such a small amount that stock returns are clearly the superior investment in the long run.

In the short run, all kinds of scary shocks will come out to spook the market, always have always will. We as small investors need to play the long game and not get distracted by the colour of the next swan.

Thanks for the discussion. It keeps me sharp.

Btw I had to do some serious rebalancing of my portfolio after being away for six months. By luck i had 3 runaway positions in my consumer descretionary sector. I would almost say that rebalancing 3 times a year is probably more prudent than twice. As much as this has given me a huge lead over the index, it could have easily gone the other way. My goal is to beat the market by 2-3…. nothing more.

I once again return to my position that I don’t need to beat the market, I just need to meet my own objectives. So, for me, preserving capital and making a modest long-term return shapes my risk parameters and lets me sleep well at night.

Since we’ve basically already got enough to retire on and I don’t have any estate requirements, I see no need for over exposure to the market. I just have to stay ahead of inflation and make enough return so that we can reasonably expect to outlive our last dollar.

I like to consider re-balancing four times a year since some securities can move pretty fast at times.

You always come up with some of the best sounding risks. Sequence of return risk sounds worse than my cat food risk.

Related to sequence risk, I read an article in forbes last year of a librarian who liquidated her stock portfolio because she achieved her financial goal of being able to retire. The proceeds went to treasury like assets which countered inflation. I am not suggesting you invest like a librarian, but i need to point out that everyone has different goals and can achieve them in different ways. I do think my ways are the best but i am biased towards my self and do realize that. I note that other investors think their ways are also best…sigh, very odd.

If i recall correctly she had invested in low cost etf like funds as well as bonds and ended up with a descent return over 30-40 years. She basically now guarantees her retirement by exiting the market and as there is no longer any volatility there is no sequence of return risk.

Oddly, she did not plan to retire from he job anytime soon….i think she was in her 60s. She sleeps well at night, but has to get up early to go to work….which is only ok if, well…you like to work.

Admittedly i may have the worse sleep as it relates to retirement income. But i mitigate sequence risk by keeping my income at 2.5% of the total. If the portfolio grows so does my annual income. This is a bit of a drawback compared to you or our hardworking librarian, as i never know what my annual income will be. The one advantage is that statistically it will likely grow over the years. I had TD Wealth run a computer model on the approach and it came in with a very high success probability. The idea here is that the portfolio needs to last 42 years for my life horizon plus another 15-20 for my younger wife. An all equity portfolio is necessary for me as i needed the higher market like returns so that i could achieve my goals of retiring in my forties and spending time writting to investment clubs.

I don’t know, I like the sound of your cat food risk. I’ve never tried cat food myself but the cat I used to have liked it quite a bit. Depending on the cat food you’re buying, some human food might actually be cheaper! LOL.

I don’t know if the librarian’s approach is suited to me – that is the opposite extreme compared to 100% in equities. I am more comfortable in the “Goldilocks” model – half in equities and half not. I don’t totally dislike work, I am a consultant, and likely can ease into part-time work before full retirement. It works for me.

You have a long time horizon to invest for so it makes more sense to be more aggressive than me. Glad you’re finding time in your early retirement to write to investment clubs. Your sense of humour and insights are appreciated.